Directors, are you across the growing interest in sustainable business models?

Interest in responsible and ESG investment is increasing. We outline emerging trends, what investors are looking for and how the performance stacks up.

There has been a spike of investor interest in assets that meet environment, social and governance (ESG) criteria. However, the increasing cachet of sustainable investing and a confusing array of investment approaches can make it challenging to fight through the jargon to separate what’s real from variations on greenwashing.

Responsible investment strategies account for more than $1 in every $2 invested in Australia, according to the Responsible Investment Association Australasia (RIAA), the peak body representing responsible, ethical and impact investors across Australia and New Zealand.

Investors who systematically consider ESG and ethical factors across the entire portfolio account for $866 billion of assets, or 55.5 per cent of all assets professionally managed in Australia, according to RIAA’s 2018 Benchmark report. There’s been a dramatic increase in funds directed into more core responsible investment strategies that include positive and negative screening. Sustainability themed or impact investments have more than trebled over the past year to $186.7b (see chart). As more investment banks, fund managers and other investors factor ESG criteria into investment decisions, directors assessing performance will increasingly have to look at non-financial ESG information to form a view.

Jack Nelson, who looks after the $1b emerging markets investments in the Asia Pacific for long-term active fund manager Stewart Investors, says, “As analysts, we are putting together a jigsaw puzzle of the quality of the companies. It’s not just a nice-to-have or a tick-box. A lot of it boils down to time horizons. We are huge fans of family companies because they think in generational terms. With that, a lot of sustainability thinking follows. [There is] consideration of non-financial risks, time horizon, alignment of managers and culture, and whether the right frameworks are in place to allow managers to think like owners.

Citing a 10-year investment in Philippines water utility Manila Water as an example, Nelson says it’s not a question of trade-off in returns. “We sometimes hear, ‘that’s great, but how much return do we have to give up in our investment?’ It’s the reverse. We show over time that it makes money. We have been running funds in Asia for 12 years and those portfolios have outperformed the benchmarks over time.” Manila Water has performed well financially while health and social outcomes have also improved.

With sustainability now a factor for consideration with organisations of all sizes, numerous approaches and business models have proliferated. Company Director explores some of the most popular and emerging approaches. While not all are equal, most are complementary or integrate with others.

UNPRI: tough new rules

Twelve years after the Principles for Responsible Investment (PRI) were launched, the UN-backed initiative has met heavy criticism over greenwashing, with one of its founders, Steve Waygood of Aviva Investors, suggesting some signatories use PRI status as a “figleaf” rather than showing true commitment to sustainability practices. Others claim the PRI lost credibility by allowing too many companies to sign up. The London-based organisation responded in May by putting on notice 185 unnamed signatories — of a global total of 1967 — who have signed up to meet six principles that are designed to embed ESG into investing practices.

The laggards have been told to clean up their acts over the next two years or face expulsion and public naming. Under PRI rules, signatories must file an annual report to the organisation detailing their ESG activities.

Fiona Reynolds, PRI managing director, has confirmed those who aren’t meeting requirements are signatories of various sizes across all regions and they’re being allowed time for their improvements to be measured. The organisation has also introduced tough new requirements demanding that half (or more) of a fund manager’s assets be covered by responsible investing policy, and explicit commitment to ESG issues by senior managers. PRI’s signatories hold more than US$70 trillion in assets under management. Among its members are the likes of BlackRock, Vanguard, Norway’s Government Pension Fund and Australian institutions AMP, Macquarie Asset Management, BT Investment Management, Australian Super, Lendlease and Perpetual.

Shared value: projects for big players

Harvard professor Michael Porter and former venture capitalist Mark Kramer introduced shared value as a strategy and framework for corporate purpose and to fix emerging economies issues over a decade ago.

Simply defined as “policies and practices that enhance the competitiveness of companies while improving social and environmental outcomes”, shared value projects essentially must be able to scale, which often happens in partnership with a not-for-profit, NGO or government.

“Scalability means its focus is on the big end of town,” says Helen Steel, CEO of Australasian peak practice body Shared Value Project.

Having Porter as its chief global cheerleader plus added impetus from NAB chair Ken Henry AC, who is its Shared Value Champion, makes conversations in C-Suites and boardrooms easier, says Steel. She reports that preliminary findings of yet-to-be-released research, conducted in collaboration with AT Kearney, show that companies are gravitating toward shared value more than other sustainability concepts.

Since its April forum, the project — with 30 local members to date, including Nestlé Australia, NRMA, Opal Aged Care and insurers AIA and IAG — has been wrangling huge interest from the private sector.

Australia’s Department of Foreign Affairs and Trade is also adding a push, recently announcing its Business Partnerships Platform as part of a modernised aid program based on shared value principles.

Impact investing: looking for scale

Best known for innovative high points such as social impact bonds, impact investing is a megatrend. It proposes investments across all asset classes should deliver a better society and environment as well as a financial return. Eighteen countries plus the European Unionare now on the Global Steering Group for Impact Investment covering different political systems, geographies and income levels, with 10 more working to join. “We’re moving quickly to 30-plus countries,” says Rosemary Addis GAICD, Australia’s representative on the group’s board and chair of Impact Investing Australia and the Australian Advisory Board on Impact Investing. However, 75 per cent of the world’s capital is still not impact-rated.

Australia was an early leader, with investment banker Michael Traill’s pioneering initiative to buy out ABC Learning and establish NFP Goodstart in 2009. The NSW government was only the second in the world to embark on social impact bonds and put impact investment on the policy agenda.

Addis is seeking $150m from the Australian government, to be matched by the private sector, for an implementation-ready wholesale fund, Impact Capital Australia, to build confidence in the market.

“We need a first mover to provide this kind of capital,” she says. “Currently, funds with this focus are too small.”

Scale is just one impediment, along with lack of intermediaries to structure the impact investments. And there’s the ongoing international quest to find a mutually agreed way to measure their non-financial aspects, which Addis believes is letting “the perfect” get in the way of “the good”.

“With regulators such as the Australian Prudential Regulation Authority (APRA) putting more requirements around climate risk, impact investing is aligned with fiduciary duty for directors and it potentially offers access to a new class of investors,” she insists. “Make a start while there’s still time for adjustment.”

The B Team: influencers in action

Still in its formative stages, the B Team Australasia is launching this month [October], and co-founder Richard Branson is slated to attend.

With Jochen Zeitz, former Puma chair/CEO and environmentalist, Branson formed the B Team in 2013 to “create a Plan B for business because Plan A wasn’t working”. A crew of 30 was assembled— Unilever CEO Paul Polman, Tata Group chair Ratan Tata, Thrive Global CEO Arianna Huffington, and Salesforce chair/CEO/founder Marc Benioff among them — to move the environmental and social wellbeing agenda and tackle failures of governance, rule of law, anti-money laundering, responsible tax practices and transparency of company ownership across the globe.

It’s a group with considerable sway. Former Lendlease senior executive Lynette Mayne AM as co-chair is creating a 30-strong Australasian team, which includes ANZ chair David Gonski AC FAICDLife as co-chair responsible for the B Team’s 100% Human at Work/Future of Work initiative, Carnival Australia CEO Ann Sherry AO FAICD, and Business & Sustainable Development Commissioner Sam Mostyn MAICD.

Sustainable Development Goals: the ultimate to-do list

Approaches to the Sustainable Development Goal’s (SDG) 17 goals and 169 targets — devised by the UN to address sustainability issues to 2030 — were reported in Company Director’s July issue, revealing how Australian companies were moving from mapping the goals to using them as enablers for strategic direction. Australia’s first Voluntary National Review on SDGs, delivered to the UN in July, highlighted progress to date, noting the number of SDG Indicators that still have no accepted methodology for collection.

Investor interest in so-called “sustainable finance” to support these goals is where there is plenty of action. In July, Australian investors and businesses came together for the first UN Environment Programme Finance Initiative (UNEP FI) conference — Financing a Resilient and Sustainable Economy. It explored how banking, insurance and investment practice and policy and regulatory frameworks could support the transition to a resilient and sustainable economy, developing a sustainable finance road maps for Australia and New Zealand. This area of sustainable finance is growing rapidly, ranging from issuing green bonds for companies, syndicated green loans that favour low-carbon developments, and providing finance for projects such as renewable energy.

The OECD estimates that US$100 trillion in infrastructure investment is required over the next 15 years to meet the Paris climate change goals. Companies and directors are under increasing investor pressure to manage climate change risks.

Green bonds are used to fund projects that have a positive environmental and/or climate benefit. Green bond issuance globally in 2017 jumped 85 per cent to hit US$161b, according to data from the Climate Bonds Initiative, with China accounting for US$36.4b.

In Australia there has been a recent wave of green bonds from the likes of NAB and ANZ, and analysts say there is a growing pool of capital looking for these kinds of investment. Hamish Kelly, head of global banking for HSBC Australia, expects green loans to become a bigger source of funding for environmental projects than green bonds. “There have been a series of firsts in the local market over the past 18 months, highlighting the potential for instruments such as green loans, green bonds and SDG bonds to become a major source of funding for climate-related projects. This trend is in a large part driven by investors.”

Ethical investment grows

Sustainability focused fund manager Australian Ethical reflects expanding investor demand.

Australian Ethical Investments is an example of the rapid growth of interest in ethical investing. The small ASX-listed fund manager has seen funds under management grow to more than $2.7 billion. The Sydney-based company continues to operate on an ethical charter it established in 1986. Among some of Australian Ethical’s international investments are Microsoft, Asahi Glass, Netflix and Dell. It does not invest in coal.

KPMG’s 2018 Super Insights report says the company’s Australian Ethical Super fund highlights the benefits of an ESG focus. With fund inflows and members increasing dramatically, it has been listed as Australia’s fastest-growing super fund for the past few years. Much of that growth is coming from the millennial generation, with its social and environmental consciousness. The company also rates well for best employer status, employee engagement and customer satisfaction.

“People join us because they’re aligned with our organisational values and they engage with the whole B Corp concept because it really brings it to life,” says Phil Vernon FAICD, managing director of the investment house since 2009.

Australian Ethical was effectively a B Corp before the concept arose. “We’ve been around for more than 30 years, with an ethical charter since we were incorporated in 1986,” says Vernon.

Underpinning the Australian Ethical philosophy is the shifting of its financial system from shareholder primacy and returns-only investing to a focus on societal and environmental impact.

The development of B Corp certification in the US in the mid-2000s gave impetus to introducing ethics into investment and corporate decision-making, says Vernon. Importantly, it delivered validation — objectivity, comparability and measurement. For Australian Ethical, B Corp status has “given us a means of internal benchmarking and made it OK for us to say we’re more sustainable than the next company.”

Not long after the movement launched in Australia in 2013, it was atypical that Australian Ethical sailed through the certification process to become the country’s first — and still just one of two publicly listed — B Corps. Most companies initially fail B Corp impact assessment, either dropping out or spending years working to improve the sustainability of their supply chains to achieve the required 80 points for certification. It’s a very rigorous process, Vernon admits. “We were already quite a way up the curve. We have conviction in terms of our approach and are happy with having to justify it biannually.”

Another major motivator to be a frontrunner for B Corp certification was Australian Ethical’s desire to grow the ethical business sector. Vernon observes the country’s B Corp movement is growing strongly, although possibly not as strongly as initially hoped due to the rigour of qualifying. Benefits come from the wider network and B Corp community. Australian Ethical uses fellow B Corps as suppliers — and scrutiny of the supply chain is a given. “We know if someone else is a B Corp they share our philosophy about how capital is allocated.”